Most organizations are adept at making bottom line improvements. Few are as quick to tackle above the line opportunities. Above the line refers to the first three categories of the income statement – Revenues, and Cost Of Goods Sold (COGS) and Gross Profit. Moving the dial on these items has a much bigger effect but which strategy would be the most effective in improving your Gross Profit?
We surveyed 300 senior leaders and asked which strategy did they think would have the most impact from the following choices:
- Increase revenues by 1%
- Reduce Cost of Goods Sold by 1%
- Raise prices by 1%
- 70% said they would sell more to raise their revenues
- 20% chose a reduction in COGS
- 10% chose to increase prices by 1%
Take a moment to make your pick and then I will reveal my answer.
We know the simple equation is:
Revenues – COGS = Gross Profit.
Let’s take an imaginary company. It has revenues of $100, COGS of $60 and so Gross Profit is $40 (100-60=40).
The following graphic shows all 3 scenarios:
And voila! Perhaps some explanation.
1. Revenue Growth Strategy.
When we grow revenues those costs (COGS) associated with them also increase by 1%. Our Gross Profit increased by 40c. So for every revenue dollar increase we get a 1% improvement
2. Reduce COGS Strategy
Here revenues stay the same and COGS comes down giving a net increase in Gross Profit of 60c or 1.5%
3. Raise Prices Strategy
If we raise prices then our revenues must increase by the same percentage. However, our COGS remains the same (input costs did not increase as we just raised price) giving us a whopping $1 or 2.5% improvement. Interestingly, this strategy was only picked by 10% of our respondents!
OK I know it is not straightforward to just raise prices. However the corollary is don’t be so quick to discount prices to win new orders as it has a disproportionate affect on the business ability to make money. Having said this here at SBTI we find the area of pricing presents many opportunities. We can often segment your business and examine the value your customers are receiving. If you sell them premium products or services they should command premium prices. If you treat all your segments the same you may be missing opportunities.
We see companies spending considerable time on discount strategy and policies. We would urge you to spend as much time considering how you can describe or engineer value to the customer thereby giving you a weapon to justify selected price increases.
Try this sensitivity test with your sales teams!
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